Inclusive growth: Why is it important for developing Asia?

4. Policies to achieve Inclusive Growth
However difficult the achievement of full employment may be, governments have the responsibility to achieve it. This requires implementing a series of strategies in different areas. I propose the following policies:37
(i) Redress the neglect of agriculture: Agriculture is still the largest employer in many developing countries in Asia, including Bangladesh, Cambodia, PRC, India, Indonesia, Pakistan, Papua New Guinea, Thailand, or Viet Nam (in 2000–2004, agriculture was still the largest employer in developing Asia in 12 out of 23 countries for which data were available). And in many other countries in the region, although it is not the largest employer, it still employs a very significant share of the labor force.
However, for decades, agriculture has been neglected in large parts of Asia. For example, in 1980, 30% of the World Bank’s annual lending went to agriculture projects. By 2007, this share had declined to 12% (adjusted for inflation, the World Bank cut its agricultural lending to $2.0 billion in 2004 from $7.7 billion in 1980). Today, the overall proportion of official development assistance going to agriculture is only 4%. Why has this occurred? An important factor that accounts for the poor state of agriculture is countries’ attempt to emulate the experience of the East Asian countries. At the time these countries started growing in the 1970s, the prevailing view was that a significant amount of labor would be transferred from agriculture into industry and services. Likewise, there was some degree of export pessimism with regard to agriculture.
The prospects of achieving fast growth in the exports of labor-intensive manufactures were much better. The experience of East Asia seemed to corroborate these views, which led other countries in the region, especially in South Asia, to also push the export-led growth route. The consequence was the neglect of agriculture in favor of industrialization, although in many cases this strategy did
not succeed to the extent that it had previously succeeded in East Asia. This is most obvious in India, where the decline in public infrastructure in rural areas has led to the sector’s stagnation. In Viet Nam, large agricultural areas are being lost in the name of industrialization. According to the Ministry of Agriculture and Rural Development, the country loses about 40,000 hectares a year of rice fields to construction of cities, highways, and industrial zones. And in Thailand, the area of land under cultivation declined by more than 13% between 1995 and 2005. This means that Asia’s food crisis may not end soon. Moreover, its solution requires international cooperation.
If growth in developing Asia is to be inclusive, then agriculture will have to be given priority. Thailand’s labor productivity in agriculture is estimated at about $1,650. In the US, it is about $40,000. Labor productivity in agriculture in the Philippines, Indonesia, Myanmar, PRC, India, Nepal, Bangladesh, and Cambodia barely reaches $1,000. There is no doubt that if developing Asian countries upgraded their agricultural practices only to the level of Thailand, millions of people would be lifted out of poverty. Another problem is the fragmentation of holdings due to population growth. In the PRC and Bangladesh, average farm size has fallen from about 1.5 hectares in the 1970s to about 0.5 hectares now.
Improvements in agriculture will require deep understanding of the transformation that agriculture can potentially undergo. One such transformation is the increasing importance of
commercialization and the role of supermarkets.
One could think that the solution may lie in reallocating the labor force out of agriculture toward more productive activities. I have in mind, for example, labor-intensive building and construction, although some industry and services activities could also serve the same purpose. The preliminary answer is yes; indeed, this is (part of) the solution. This encounters, however, an important obstacle. This is the bottleneck of supply of necessities (resulting from the low elasticity of agricultural production) that would arise. Indeed, an increase in employment outside agriculture creates additional income (wages) and, given that workers spend a considerable part of their wage bill on food, if there is no concomitant increase in agricultural output, food inflation will show up. How could policymakers avoid such inflationary pressures? Perhaps the first obvious measure would be to tax necessities (mostly consumed by low-income groups) to contain food inflation. This, however, is not a solution if policymakers aim at achieving inclusive growth. Indeed, increasing employment at the expense of a decrease in real wages should not be acceptable as a policy option, for it amounts to taxing the poor rather than the well-off on the grounds that the latter would not reduce their consumption despite the imposition of a tax (apart from the fact that it limits the expansion of the market for mass consumption articles, an important factor of industrialization). Nevertheless, taxation of the upper-income groups would probably only slightly depress the demand for food, and hence inflationary pressures would remain. Imports of food can also help relieve the problem. These, however, will require that the country in question export enough to pay for its imports. Otherwise, it will run a trade deficit. For this reason, in general, the increase in food supply will depend on domestic output.
If the increase in food supply will largely depend on increasing domestic output, policymakers will have to plan an increase in the supply of food (i.e., an increase in agricultural output), and in general of consumer goods, that matches the demand for them. Therefore, an increase in agricultural output is crucial for many developing countries to initiate economic development. This policy also matters because many developing countries today have a higher density of population on their land than most developed countries had at the time they underwent structural transformation and modern growth. The developing countries are also experiencing higher population growth than the developed countries ever experienced. For this reason, a complementary policy is to prevent large-scale migration from the countryside into urban areas. This requires agricultural policies aimed at absorbing more men per acre and the industrialization of the country side.
(ii) Undertake public investment in basic infrastructure (energy, transport, urban services) targeted at high-employment projects: As I noted earlier, Kalecki argued that the best way to achieve and maintain full employment was by Government spending on public investment (e.g., schools, hospitals, highways, etc.).38 This policy recommendation remains valid today.
A dynamic economy will need increases in the growth rate of the capital stock (i.e., capital accumulation) in the form of, among others, investment in public transportation and in public utilities. Increases in the growth rate of the capital stock can be achieved in two ways. The first one is to increase the productivity with which capital is used. This route, however, is very difficult. In fact, the empirical evidence shows that capital productivity tends to decline in the long-run.39 It seems that development entails increases in labor productivity combined with decreases in capital productivity.

The second mechanism to increase the growth rate of the capital stock is to increase the investment-to-output ratio. This is the basis for a policy of industrialization, and is the one followed by the successful East and Southeast Asian economies. The importance of investment for development is crucial. There is no lack of candidate projects: schools, hospitals, transportation, power and telecommunications, are all under-served in much of developing Asia. This is because it plays a dual role. On the one hand investment expenditures are a source of demand when they are incurred. And on the other hand, investment increases the productive capacity of the economy in the long run. This second role is the one I consider here.*
How did the successful Asian countries increase their investment-to-GDP ratios? To see this, it is worth considering the relationship between the labor share, real wage rates and labor productivity. In a context of full employment, if there is a rise in labor productivity, and if the labor share is approximately constant, real wages will have to increase. But it is also possible that the labor share decreases and yet workers see their real wages increase. This will happen if productivity increases fast but such increases are not passed on to wages one-to-one (but these nevertheless increase fast too). Under these circumstances wages will increase by a lesser amount than labor productivity and thus the labor share will decrease. Workers, although they see their share in total income decrease, would tolerate the situation. This was possible in many Asian countries because there was little militancy in the labor force, partly because of a substantial labor surplus in the economy, and partly because of repression by state agencies.
While some Asian countries made huge efforts toward increasing investment (much of it into the manufacturing sector), it is important to also understand that these countries were initially somewhat lucky. In the late 1960s, the developed world started experiencing important internal changes that led them to relocate entire industries or particular industrial processes to the Third World. One important reason was the increase in wages in the advanced economies, resulting from the fact that the social contract established after World War II favored labor. At the same time, rapid technological progress led to the development of highly standardized manufacturing processes. This made it possible to transfer particular stages of production, namely, the labor-intensive processes that required low-skilled workers. What options did companies in the developed world have? Only two: Latin America and East and Southeast Asia. However, Latin America was ruled out for being much more politically unstable. This left only Asia. Thus, in the late 1960s, a number of electronics firms, including Hewlett-Packard, Texas Instruments and others, built factories in Singapore to assemble components, particularly semiconductors. This process was extended to Malaysia, Thailand and the Philippines. But what were the internal conditions that enabled capitalist South-East Asia to respond to the opportunities created by restructuring the industrial core? Brown argues that “one crucial condition [..] was the presence of a copious supply of cheap, largely unskilled, and essentially docile labour”. To this one must add the role of women, whose “dexterous fingers and patient temperament fitted them for such repetitive, minutely detailed tasks as electronic components assembly or garment production”; and weak labor unions.

This is today an important component of what is referred to as ‘China’s competitiveness’.*, 40
A second condition was that Southeast Asia was resource-rich (except Singapore). This gave it an important advantage in the production of manufactures such as wood products, processed foods, cement, chemical fertilizer and paper, all of which involve the intensive use of local inputs. Finally, a third condition is that these countries possessed an acceptable level of communication, commercial and administrative infrastructure.
However, a dose of luck and these internal conditions do not explain entirely the success of East and Southeast Asia. The key lies, I believe, in the social contract implemented in many countries, and in the political pressure derived from the communist threat.41 Underlying these, there was a series of complex structures of political, economic and bureaucratic interests that favored the accumulation of capital.
Naturally, the counterpart of the decrease in the labor share was the increase in the capital share. A good deal of evidence suggests that capital accumulation for industrialization is largely financed by profits in the form of retentions, rather than by household savings.42 Indeed, according to Lewis: “…the major source of savings is profits, and if we find that savings are increasing as a proportion of the national income, we may take it for granted that this is because the share of profits in the national income is increasing.”43 Over the long run, a high rate of retained profits tends to be associated with a high rate of corporate investment. Using data for 30 developing countries for the 1980s, Ros showed that there is a strong relationship between a high savings rate, a high share of manufacturing output in GDP and a high profit share in manufacturing value added in East Asia.44
It is important to emphasize a key point about this strategy of industrialization (i.e., the increase in the share of investment). This is that real wages should not fall in the process. This requires both a high rate of labor productivity and that the prices of essential consumer goods be stable, which implies that their supply must rise in step with their demand. Achieving this will also require that investment in the different sectors of the economy, in particular in the capital and consumer goods sectors, be undertaken in the “right” proportions. And it will also necessitate, as already noted, the adjustment of the rate of growth of employment to the limit set by the increase in food supply and articles of mass consumption in general. Certainly this is not easy. Moreover, maintaining the purchasing power of wages is also important because declines in real wages limit the expansion of the market for mass consumption articles. However, given the importance that I have placed on the objective of full employment as the basic measure of a socially equitable economic policy, it may appear that the constraint that real wages do not decrease could pose a problem. For this reason, the lower acceptable limit for society should be that real wages be stable for the better off workers and wage rates of the bottom workers increase. To be more precise, inclusive growth should favor policies that encourage faster wage growth for low-paying jobs than for highly-paid work. This means that, at the low end, wage growth will exceed productivity growth, while at the high end productivity growth will exceed wage growth. This proposal is consistent with the idea of broad-based growth, which should translate into development efforts directed toward raising the standard of living of those at the bottom. This policy implies that, most likely, prices will grow in the low-wage sector as costs rise. Preventing inflation will require some constraint on prices and wages in high wage sectors.45, 46, 47, 48
What is the impact of this development strategy on consumption? Given that workers have a high propensity to consume, the decrease in the labor share will affect overall consumption. How should policy makers proceed, i.e., what consumption categories should be reduced? In order to accomplish this in a “fair manner”, policy makers would have to restrain the consumption of non-essentials (something that politically is very difficult). For this, appropriate taxes should be imposed. In these circumstances, an acceleration of income (induced by the acceleration of investment) will be accompanied by an increase in the supply of necessities adequate to prevent inflationary pressures. Thus, a higher share of investment in output will be offset by a decline in the share of non-essential consumption via direct and indirect taxation of the upper classes. At what point is the share of investment too high and that of consumption too low? This is difficult to ascertain but there will be signals. Profitability may decrease precipitously leading the economy into a profitability slump. On the other hand, if authorities are not careful and the share of consumption of essential goods goes down, the problem might be under consumption.
(iii) Use of industrial policy, understood as a collaborative effort between public and private sectors, to accelerate industrialization and structural transformation in general: How can developing countries induce structural change and plan transitions to higher growth rates and deeper degrees of structural transformation and diversification? This is a fundamental aspect of the problem of developing countries (the need to increase productive capacity). Indeed, the transition from agriculture into a modern industrial and service economy, and decisions about how much to invest and where, can be viewed as problems of self-discovery and of understanding the externalities that lessen incentives for productive diversification. Today’s developed countries directed policies to industrialize. Chang argues that today’s developed countries—such as the UK, Germany, France, the US, Sweden, and Japan—used industrial, trade, and technological policies when they were developing and catching up.49 They used some form of infant-industry policy or tariff protection. More recently, many East Asian countries also used infant-industry protection measures to develop their industrial sectors.50
Industrial policy has traditionally been understood as any type of selective intervention or government policy that attempts to alter the structure of production toward sectors that are expected to offer better prospects for economic growth than without such intervention. This type of intervention has its adherents—those who believe in market failures—and its detractors—those who believe in the efficient working of markets. The latter argue that industrial policy interventions have often degenerated into an exercise in “picking winners”, a game played by government officials deciding what activities and sectors to promote and to spend public money on.*
In a series of papers, Rodrik has argued in favor of a new type of industrial policy. He acknowledges the existence of generic market failures, but argues “that the location and magnitude of these market failures are highly uncertain”.He argues that information and coordination externalities are more important than technological externalities, for the former weaken the entrepreneurial drive to restructure and diversify low-income economies. Rodrik argues that industrial policy is not about addressing distortions in the traditional way (i.e., by enumerating technological and other externalities and then targeting policy interventions on these market failures), but about eliciting information from the private sector on significant externalities and about the constraints to structural transformation (hence industrial policy also encompasses activities in agriculture and services) and the opportunities available. This requires “strategic collaboration” between the public and private sectors to determine the areas in which the country has a comparative advantage. The reason is that entrepreneurs may lack information about where the comparative advantage of a country lies and governments may not even know what they do not know. And certainly most governments do not have the adequate knowledge to pick winners. Uncertainty arising from lack of communication—that is, from one decision-maker having no way of finding out the concurrent decisions and plans made by others—may, if sufficiently great, inhibit investment decisions and arrest growth. In these circumstances, markets alone are likely to undersupply the incentives and demand for new activities necessary to transform the economy. These market failures are more prevalent in developing economies. As Rodrik notes: “The trick for the government is not to pick winners, but to know when it has a loser”. This requires the development of the appropriate institutional arrangements for industrial policy. 51, 52
Industrial policy should be conceived as a joint effort of the state and the private sector to diagnose the sources of blockage in new economic activities and propose solutions to them. Industrial and technological upgrading requires purposeful effort in the form of industrial policy, in particular, effective government action and public-private collaboration. But this needs, first, a government that does not take any particular stand on the activities to be promoted or the instruments to be deployed. It only requires the government to build the private-public institutional setting from which information on profitable activities and useful instruments of intervention can be extracted. The key issue is not whether to protect, but how to protect and promote industry in order to ensure technical progress leading to higher labor productivity.* And second, it needs a private sector that is willing to do its part of the deal, i.e., invest. Understood this way, industrial policy is a powerful tool for successful industrialization and structural change.
(iv) Gear fiscal and monetary policies to the achievement of full employment: Although Governments do understand the problems associated with unemployment and underemployment and make efforts to solve them, the reality is that some of the policies they implement run in the opposite direction. There are several reasons that explain this.53 In essence, the “deficit fetishism”, as Stiglitz et al. refer to it, does not allow Governments to fill the difference between the saving desire of the private sector and the required spending of an economy to run at full employment.54 Modern Governments that operate with fiat currency are not operationally constrained (like a family). Moreover, given how modern economies work, budget deficits do not lead to increases in interest rates (as the loanable funds model predicts) and do not crowd out the private sector. In fact, government spending adds, dollar for dollar, to the country’s overall savings. And given that often economies operate below full capacity, government spending is not inflationary. Given this, Governments should spend enough so as to bring the economy much closer to full employment. When this state is approached, then it is true that further spending will lead to inflation. Then there will be no reason for further Government spending (i.e., fiscal deficit). Or put in different terms: if the private sector spent enough so as to bring the economy close to full employment, then there would be no need to run fiscal deficits.
The case for a budget deficit depends on what the deficit is for, and not on what may appear to be sound or unsound according to any established traditional doctrine. Judging fiscal measures by the way they work or function in the economy is known as the doctrine of “Functional Finance”. As with all macro policies, budget deficits should be judged in relation to the results. Moreover, budget deficits have different impacts depending on whether the economy is at full employment or far from it. In the former case, deficits are likely to have adverse effects, e.g., may crowd out private investment by increasing interest rates and lead to inflation (due to excessive aggregate demand), although the empirical evidence linking cause and effect is scant. If the economy is not at full employment, a deficit need not crowd out private investment. Therefore, a budget deficit incurred to achieve full employment should, at least, be considered.
It should not be inferred from these arguments that I am proposing budget deficits without limits. The size of the deficit is market-determined by the desired net saving of the private sector. Full employment is the limit. For this reason, functional finance is not about spending without limit.
The discussion above indicates that government expenditure and fiscal policy in general should be seen from the point of view of how to keep the total spending in the economy at the rate that would buy all the goods that it is possible to produce. Fiscal policy should be conceived as a mechanism that balances the system, exogenously increasing aggregate demand (e.g., by injecting expenditures) whenever private-sector spending falls short of a full-employment level of effective demand, and reducing aggregate demand (by taxing) if this exceeds the full-employment level. This also means that the purpose of taxation is not to finance or allow government spending, but to remove spending power from the private sector so as to reduce current aggregate demand, and maintain the (government-created) demand for the government’s money. The key is to ensure that government spending is at the right level to induce neither inflationary nor deflationary forces. However, given the usual private-sector preferences regarding net saving, economic growth will most often require government deficits. Until full employment is reached, deficits can be increased to allow incomes to rise. Once full employment is reached, additional deficit spending will generate additional income that most likely will induce inflation.* This also means that, in general, unemployment is the evidence that the government’s deficit is too low. Deficit spending increases incomes and generates additional spending, and thus additional employment. This additional spending will most likely stimulate the private sector, create more jobs, and reduce unemployment.*
Inflation, and the policies to contain it are also controversial. Inflation can potentially damage developing countries because it erodes the purchasing power of wages and shifts the burden of financing development to workers. This is unethical and conflicts with the idea of inclusive growth. Price increases that lead to real wage reductions (especially for the workers at the bottom of the wage distribution, for whom low inflation is a public good of special importance) are inconsistent with the notion of inclusive growth, and measures should be taken against inflation.
However, Stiglitz et al. (2006) argue that there is considerable confusion about the role of price stability in an economy. Inflation is interpreted by many as an indicator of economic malperformance. The problem with this view is that the indicator is interpreted by many as a policy objective, when in reality it is only an intermediate variable. Unemployment, meanwhile, argues Galbraith, “has become a price-stabilizing instrument… [because] . . . those who have political voice and influence are more damaged by inflation than by unemployment”.55 The key lies in understanding the causes of inflation, for these have different implications for economic policy.
The misunderstandings about what causes inflation, the belief that low inflation is a pre-condition for growth, and the implications of inflation for the rest of the economy are often a source of confusion. There is a widespread perception that many governments have used unemployment as a way to contain inflation. Surely inflation is bad, but the social costs of unemployment are much worse. Moreover, empirical studies show that (i) low inflation is not associated in general with high growth; (ii) hyperinflation is associated in general with low growth; and (iii) moderate rates of inflation, 20–30% per year, have been associated with rapid growth quite often. This means that, “given the uncharacteristically unified view among economists and policy analysts that countries with high inflation rates should adopt policies that lower inflation in order to promote economic prosperity, the inability to find simple cross-country regressions supporting this contention is both surprising and troubling”.56 Overall, no scientific evidence suggests that a necessary condition for faster growth is that inflation should be as low as possible. What is truly damaging for an economy is unpredictable, unexpected, and volatile inflation, but not steady and predictable inflation. We must, therefore, be concerned with the likely sacrifices being made by many developing countries in terms of output losses (and, consequently, employment) as a result of trying to maintain very low inflation rates. This is even more obvious when moderate inflation around the world is not clearly the result of central banks’ policies rather than the result of the increased competition that derives from globalization. The conclusion is that probably many countries can afford slightly higher inflation rates, possibly permitting higher growth and employment, without derailing the economy.
(v) Devise Job Guarantee Programs (JGP) to ensure full employment with price stability: Most governments are in a position to promote full employment through direct job creation through the implementation of Job Guarantee Programs. Long-term unemployment and underemployment may be due to skills mismatch or problems with the individuals who are unemployed, in which case the solution is job brokerage or training. But if the problem is job shortage, then improving the match between job seekers and vacancies, as well as training, will not do much. In this case, only direct job creation by an employer of last resort that can offer an infinitely elastic demand for labor can ensure full employment. This is the only way to ensure that everyone who wants to work will be able to obtain a job. Only the government can do this. The JGP is a theoretically solid proposal that provides a mechanism to ensure full employment with price stability.
The JGP is essentially a fixed price (the public-sector wage)/floating quantity (public-sector employment) system that acts as a countercyclical mechanism and as a buffer stock program: when the private sector downsizes in recessions, workers who lose their jobs can find a job in the JGP. And when aggregate demand increases, these workers are hired again by the private sector. The system can be implemented in a variety of ways, depending on circumstances. Under this scheme, the government pledges to hire anyone willing to work at a basic public-sector living (i.e., decent) salary, and the wage bill is paid for by deficit expenditure. But the program does not replace either private-sector or other public-sector employment. The JGP basic salary will act as a minimum wage that will put a floor to wages. It will reduce the downward pressure on wages and will help reduce inequality. If it is appropriately designed, it can connect wages and productivity growth, something critical for building a sustainable demand generating process. This minimum wage will depend on the country, but it could be, for example, a fixed percent of the median wage. This way, it will automatically rise with the median wage, creating a true floor that moves with the economy. Moreover, since it is set with reference to the local conditions in each country, it will reflect what the country can bear.
Authors who propose a JGP argue that this service does not replace unemployment with underemployment and that it is not inflationary.*, 57 JGPs contribute to maintaining full employment with inflation control. When private-sector demand is high enough to cause wage-price pressures, governments can manipulate fiscal and monetary policies (preferably the former) to reduce them. The resulting increase in JGP employment indicates the degree of private-sector slack that is necessary to solve the distributional struggle that causes inflationary pressures.
JGPs are not inflationary because public employment may be directed toward public works such as infrastructure revitalization that might lead to higher productivity growth in the private sector. This system can help diminish inflationary bottlenecks, as workers in it are available to the private sector. Therefore, in the view of its proponents, an economy can both have stable prices and eliminate unemployment. They also argue that workers’ productivity will increase because workers taking part in the JGP will gain skills and knowledge. Workers engaged in the JGP can provide goods and services that markets do not provide, or that are too expensive for poor households (e.g., child and elderly care, tutoring, public safety); small-scale public infrastructure provision or repair (e.g., clean water and sewage projects, roads); or low-income housing.* Many of these activities would contribute to the decline of the informal sector as workers get integrated into formal employment, gaining protection by the labor laws. Jobs created in these programs are labor intensive, requiring little capital equipment. Finally, and somewhat ironically, the JGP can be viewed as a mechanism that contributes to enhancing the flexibility of the labor market: it is a reserve army of the employed, not of the unemployed!

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